With some home equity loan rates under 3%, here’s what you should — and should not — use that money for

 With some home equity loan rates under 3%, here’s what you should — and should not — use that money for

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Americans now have an estimated $8.1 trillion in home equity, and many hope to tap into that money to fund remodeling, renovation and other projects. And no wonder: Rates on home equity loans — which let homeowners borrow money that’s secured by the equity they’ve built up in their homes — are low. Indeed, as of mid-August, the average home equity loan rate was 5.33%, according to Bankrate, and some banks like KeyBank, are offering rates for some borrowers that are under 3%. (See the best home equity loan rates you qualify for here.) Because borrowers can lock in a rate with a home equity loan, the low interest rate environment may make this type of debt more compelling to borrowers who recognize that rates aren’t likely to be this low again, says Howard Dvorkin, a certified public accountant and chairman of Debt.com

But it’s not always easy to secure these loans: Many banks tightened their approval standards in 2020 and some lenders even temporarily suspended offering home equity loans (and other home equity debt) altogether — a problem that has persisted into 2021, as The Wall Street Journal recently reported. The good news: There are still plenty of lenders willing to extend home equity loans to homeowners; shop around for the lender that best meets your needs.

Of course, your rates will vary significantly based on credit score, the amount of equity in the home, and the amount someone is looking to borrow, but experts say now is still a good time to lock in a relatively low interest rate for a home equity loan. Here’s what you need to know before you do. (See the best home equity loan rates you qualify for here.)

Take out the home equity loan for the right reasons

Too often, Dvorkin hears of people using home equity loans (or home equity lines of credit, aka a HELOC) for non-home related expenses, like paying for a vacation, a new car, or to pursue a “hot” investment tip. “I can’t recommend strongly enough against that,” he says.

Indeed, it’s taken years (or even decades) to build up equity in your home, so it’s important to use a home equity loan to finance something that adds future value — such as certain home improvements, like a kitchen or bathroom remodel, says Dvorkin. “If you’re deploying the money you’re borrowing into things that are likely to appreciate, I’m OK with it,” Dvorkin says. Even so, adding a pool may not necessarily add to the value of your home, so avoid projects that don’t add much “bang for the buck,” he adds.  And beware that some costs, like lumber, are still high, so make sure you evaluate the return on investment for any project your might do.

Keeping the purpose top-of-mind is important because interest on a home equity loan can be tax deductible, provided it’s used on the home, says Brian Walsh, a certified financial planner and senior manager of financial planning at SoFi. The IRS outlines that the interest on these loans is typically deductible if used to build an addition to an existing home — while paying for personal living expenses (like credit card debt) is not. 

That said, experts say that it can make sense to use home equity loans, which tend to have lower interest rates, to consolidate high-interest debts, assuming you know you can repay the loan. Just remember that home equity loans are secured by your home, so if you cannot repay them, you can lose your house. You may also want to consider a personal loan if you need to deal with high-interest debts. Bottom line:  “You want to make sure if you’re borrowing money or tapping into home equity using it for productive purposes,” says Walsh. (See the best home equity loan rates you qualify for here.)

Look beyond the interest rate

Home equity loans have become a timely topic because so many homeowners are undertaking improvement projects around the house or tackling debt, says Walsh. It doesn’t hurt that interest rates remain low by historical standards — and there’s a seasonality aspect because many people are more likely to undergo home improvement projects in the spring through fall months, he adds.

That said, it’s important to understand the terms of the loan, and what could trigger a default or any potential changes to the terms. Whereas you don’t have to put up a tangible asset to take on credit card debt, with a second mortgage, the equity in your home is the collateral for the debt, Dvorkin says. “I always get nervous when somebody has the ability to extract equity out of a home, which is meant as a long-term asset.” (See the best home equity loan rates you qualify for here.)

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